US Dollar at the Rubicon!...

By: Clive_Maund

As many of you may recall, on the site we had earlier been wary of a substantial dollar rally, which was a big reason for fearing that a Double Top may be forming in gold and silver. However, the mounting evidence of an incubating major advance in the Precious Metals and PM stocks over the past few weeks, specifically signs of substantial accumulation of the larger PM stocks and the increasingly bullish COT profile of both gold and silver, have led us nevertheless to turn strongly bullish on the sector.

This, of course, has led to an inconsistency with a bullish outlook for the sector in the face of a potential dollar rally, which, although it could occur, is improbable. This inconsistency was fortunately resolved at last by the dollar's action over the past week, although the situation is not yet conclusive.

The reasons for being wary of a dollar rally were that a bullish Falling Wedge had formed on its chart above a very important long-term support level, which is shown on the 3-year chart lower down the page. Last week however, it broke DOWN from this wedge, thus opening out the channel, although the break is as yet marginal, which is why the situation is not conclusive, as regards the dollar that is, not the PM sector. Although not conclusive, this action was definitely bearish in purport. Before looking at the 3-year and very long-term dollar charts, we will start by looking at a 9-month chart, so that we can examine recent action in some detail and see just how oversold the dollar is.

On the 9-month dollar index chart we can see the severe drop in the dollar over the past 4 weeks or so. There are several important points to observe here. The first is that, in comparison with the countertrend rally last December that ran into early January, the countertrend rally that preceded this latest drop was weak - its rate of ascent was less steep and it didn't even get near its 200-day moving average before it turned on a dime and headed south again.

This was bearish behaviour. In addition, on the way down, it didn't tarry long at the support at the late April low before it broke dramatically lower again, and last week it went on to break down from the potentially bullish Falling Wedge. Although this break is so far marginal, we are going to know the score soon enough, as it is now once again just above the enormously important long-term support in the 78 - 80 area, which the appalling and intractable fundamentals certainly suggest is going to fail.

However, it is important here to recognize that the dollar is now very oversold short-term, as shown by the RSI indicator on this 9-month chart and by the Stochastics on the 3-year chart below. So how is this likely to play out? Bearing in mind the decidedly bullish situation in the Precious Metals, the most probable scenario is that we will see a brief countertrend rally by the dollar, and then it will drop again - this time breaching the crucial support in the 78-80 area.

On the 3-year chart for the dollar index we can see the large Falling Wedge pattern that has developed since the middle of last year. This is a bullish pattern and was the principal reason for our earlier fearing a Double Top might be forming in Gold and Silver. However, last week it broke down below the lower boundary of the pattern, thus starting to open out the channel, and increasing the risk of a plunge should the key 78 - 80 support level fail. Despite being thus far a marginal break this was bearish action, and so although it may rally briefly back into the wedge channel to alleviate the current oversold condition, it should then turn lower again.

The enormous importance of the support on the dollar index chart at 78 - 80 is amply illustrated by the long-term chart which reveals that declines have been arrested and reversed on no less than 4 previous occasions at this level, dating back to the early 90's - in 1991, 1992, 1995, and latterly in 2004 - 5. If this level fails, it is likely to trigger an avalanche of computer and program generated selling which can be expected to drive it quickly lower, probably to the 70 area initially.

Our tactics are now clear - watch for a weak countertrend rally in the dollar over the short-term, meaning over the next week or maybe two, that will probably result in a reaction in the Precious Metals and PM stocks, which there is certainly scope for technically after the significant rally of the past several weeks, and use it as an opportunity to load up across the board in gold and silver and Precious Metals stocks. The latest COT figures are suggesting a short-term reaction is likely. This will probably be the last chance to take positions at favorable prices before the anticipated major uptrend gets underway.

By Clive Maund
CliveMaund.com

© 2007 Clive Maund - The above represents the opinion and analysis of Mr. Maund, based on data available to him, at the time of writing. Mr. Maunds opinions are his own, and are not a recommendation or an offer to buy or sell securities. No responsibility can be accepted for losses that may result as a consequence of trading on the basis of this analysis.

Mr. Maund is an independent analyst who receives no compensation of any kind from any groups, individuals or corporations mentioned in his reports. As trading and investing in any financial markets may involve serious risk of loss, Mr. Maund recommends that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction and do your own due diligence and research when making any kind of a transaction with financial ramifications.

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